Savings Interest Rates Hit New Lows
In the wake of the unexpected EU Referendum outcome the Bank of England have reduced their base rate from the 2008 “emergency level” of 0.5% to a previously unthinkable 0.25%, with Governor Mark Carneyâ€™s assistant already suggesting a further cut may be imminent.
Some would argue that through Mr Carneyâ€™s pre-Referendum predictions of doom and gloom in the event of an Out vote he backed himself into a corner, whereby his actions had to match his words? Only time will tell, but it has certainly caused more dismay and exasperation for savers, with typical savings account interest rates now hovering barely above zero.
What should we make of this current drought of risk-free returns and what action, if any, should be taken? Here are some of my thoughts:
1. Everyone needs some cash savings
Since the crash of 2008 it has been almost a global policy to punish savers and encourage spending and investment in assets that carry a degree of risk, such as Shares, Property, Corporate Bonds and Government Bonds. This risk has been largely rewarded to date, helped by very loose Central Bank monetary policy in almost all developed countries around the world.
It can be tempting then to abandon savings accounts, with their seemingly miserable interest rates, and take on some more risk, but this is not something I encourage. In fact a staple agenda item of any client Annual Review Meeting is “Do you have enough cash savings?”
Be it in a Savings Account, Cash ISAs or National Savings (e.g. Premium Bonds), readily accessible cash remains an essential part of any financial plan.
Defining “enough” is a personal thing, but a good yardstick is Â£10,000 or Â£20,000 for a couple, potentially a lot more for those with a lower risk tolerance.
Regardless of impressive investment returns, the cash balance should be topped up if necessary, so that any short-term turbulence within investment markets can be allowed to pass, without calling on a significant sum at the most inconvenient time.
2. Inflation remains low
The official annual inflation figure in the UK at present, the Consumer Price Index, which includes the cost of transport, housing, utilities and food, is 0.6% (August 2016).
If the figure is to be believed, the real value of money i.e. the purchasing power, is not being significantly eroded and even a modest Cash ISA, for example, is retaining the real value of the sum deposited.
Distant memories of having our Building Society books made-up with 6% interest, then skipping down the high street with a broad smile, were an illusion really, with inflation at 5% or more meaning the real outcome was little different to today â€“ it just felt a lot better.
3. Seeking “the best” interest rate
I detect many people are becoming weary of moving their cash savings around, from one teaser introductory rate to the next. It seems barely worth the effort for most.
There are also some potential dangers lurking too, with some of the more obscure institutions which offer a little more than the household name giants.
Always check that any Savings Account offers the protection afforded by the FSCS Deposit Guarantee, currently at a maximum of Â£85,000 per individual per institution.
A glance today at the “Best Buy” tables suggest the highest Instant Access Account interest rate is 1.00% AER offered by RCI Bank UK. Not an instantly familiar name, it must be said.
On closer inspection, this French Bank operates in the UK under the European Economic Area (EEA) passport scheme. In practice the deposit guarantee is provided by the France Depositor Guarantee Scheme up to â‚¬100,000.
Now, I know little about this particular French Bank, nor indeed the viability of the French equivalent to the FSCS, but it certainly falls into “the same but different” territory. Savers need to be fully aware of just who they are depositing their money with.
4. Not all Savings Bonds are the sameâ€¦.
Finally, Savings Bonds can mean two or three different things and the difference is rather crucial.
Savings Deposit Bonds are simply conventional savings accounts with a fixed term, usually from one to five years, with a pre-defined fixed rate of interest. Current rates are in the realm of 1% at the short end and 3% p.a. for a 5-year term.
The longer term is rewarded, although any spike in inflation would certainly impact the real rate of return over the period in question.
The other types of Savings Bond are not always what they seem and can carry considerable risk in some cases:
Structured Savings Bonds
These offer a potential return considerably higher than a deposit account, but may rely on an investment index, such as the FTSE 100 Share Index, being higher, or reaching a certain target at the end of the fixed term.
Failure to do so may mean simply a return of capital, without interest, at the end of the term, but in some cases may result in a reduction of capital too.
“Income Bonds” & “Mini Bonds”
These are two titles I have recently seen given to products that clients have asked me about. I also see them advertised on TV and in newspapers, invariably with a prestigious sounding name and branding.
Offering 5.2% p.a. and even 8% p.a. in one case, these products can look like Savings Bonds but are in fact anything but. The small print of these unregulated and unprotected investment products reveal that “capital is at risk” and this is because your money is being lent to other parties.
I am not saying that a loss is guaranteed, or even that the promised returns wonâ€™t materialise, but there is significant risk to capital involved, certainly if the UK economy took a turn for the worst.
In summary the age old maxim “If it sounds too good to be true, it probably is” remains a sound one.
Please be wary of any “Savings Account” or “Savings Bond” offering returns above 2% at present and always make sure you read the small print. If you are still tempted, I will happily run the rule over it for you and give you an unbiased opinion. Not everything does what it says on the tin.